Kilduff: Why Oil Could Rise To Last Summer's Prices

Crude oil prices continue their ascent, as traders attach reasons to buy to varying rationale on a daily basis. The dollar’s precipitous decline and brimming hopes of an economic recovery are the oft-cited reasons for the rally even, as many commentators decry the rally as nonsensical and unsustainable. Similar to last year, when prices reached $147 per barrel, sustainability will become an issue; however, at this point, the move higher is not entirely nonsensical.

There is a compelling fundamental case to be made. There has been a serious regime of supply constraint undertaken. Saudi Arabia has led OPEC in curtailing output. The Kingdom has been actually under producing their quota for several months. The large decline in US oil imports is likely a direct result of Saudi cutbacks.

The North America oil and natural gas rig count has been cut by more than half in less than a year’s time. This represents a dramatic curtailment, and the hopes for a prolonged period of low natural gas prices will be most affected.

Gone somewhat unnoticed has been the reduced operating rate of the US refining industry. Operating rates fell back, again, in the latest report from the Department of Energy, showing the industry producing refined products at a low 85 percent of capacity.

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In the background, but also supportive, are brewing geopolitical developments. The energy markets dodged a bullet with the election losses by Hezbollah in Lebanon, but tomorrow, Iranians will go the polls and, regardless of the outcome, attention will have to be paid.

If the incumbent, hard-liner Mahmoud Ahmadinejad, wins re-election, Iran’s efforts to become a nuclear power will continue apace. Ahmahdinejad is powerful in his obfuscation. While his political opponents and other senior Iranian government officials have distanced themselves from his recent holocaust denials, it is entirely consistent with his and Iran’s antipathy toward the Jewish State.

The leading contender to supplant Ahmahdinejad, Mir Hossein Mousavi, interestingly, would represent a change of some significance. It has been incredible to read reports of his outreach to women voters, especially, as a path to electoral victory. This contrasts with Ahmadinejad’s recent crackdowns on the rights of women.

So, what is the problem? Iran’s Revolutionary Guard appears none too pleased with the prospect of regime change. In fact, there is fear by the Guard of a “Velvet Revolution” occurring.

If the army moves to invalidate an election victory by Mousavi, the resulting instability would cause tremors, once again, in the region and in the oil markets. Iraq, Israel, and Iran’s neighbors would be rightly concerned about the fallout. Accusations about “outside interference” would quickly surface, and worries about a potential reaction by Iran would mount.

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If a victory by Mousavi goes unchecked, there is a possibility for the Obama Administration’s recent overture toward Iran to be more accepted and even acted upon to a small degree. Iran’s oil and natural gas industry has been greatly impacted by the decades long sanctions regime, and the ability to access western oil company technology holds great appeal. However, it would be imprudent to calculate in any wild optimism on that front.

The likely victory by Ahmadinejad will be enough of a concern. He will likely take the victory as a mandate to complete Iran’s matriculation into the nuclear arms club. This point of view will raise anxieties within Israel, and its newly elected Prime Minister, Benjamin Netanyahu, appears more inclined than his predecessor to set back Iran’s progress through a military strike.

In an editorial in today’s Wall Street Journal, former United Nations Representative-designate, John Bolton, set forth the reasons supporting such a strike and the likely outcomes. I take umbrage with Mr. Bolton’s assertion that hedging by energy traders will limit any resultant oil price spike, and his open calculation of the use of Israeli nuclear weaponry in such a strike makes the stakes almost incalculable.

Tomorrow’s election in Iran will potentially have large implications for the geopolitical element of energy prices. It could prove sufficient to further sentiment and add another leg higher to the recent rally. If fundamental underpinnings, such as today’s drop initial jobless claims, continue – tomorrow we get a consumer sentiment reading – the unabated upward pressure experienced last summer will be revisited by the energy markets.

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John Kilduff

John P. Kilduff Senior Vice President Of Energy at MF Global Ltd. He's also a CNBC contributor.